class: center, middle, inverse, title-slide .title[ # Principles of Microeconomics ] .author[ ### ECO 2306 ] .date[ ### <em>Fall 2022</em> ] --- class: center, middle, inverse # Chapter 15: ## Monopolies and Antitrust Policy --- ## Monopoly .panelset[ .panel[.panel-name[Intro] .pull-left[ Monopoly is the last of the four market structures we study - Perfect competition - Monopolistic competition - Oligopoly - Monopoly: firm that is the only seller of a good or service that does not have a close substitute ] .pull-right[ <img src="data:image/png;base64,#images/monopoly_man.gif" width="40%" style="display: block; margin: auto;" /> ] Why study monopolies 1. Some firms truly are monopolists or near-monopolists, so it is important to understand how they behave. 2. Firms might collude in order to act like a monopolist, and knowing how monopolies act helps us identify these firms. We will also consider how governments should react to monopoly ] .panel[.panel-name[Do They Exist?] .left-column[ Broad definition... so consider some examples: - The owner of a patent or copyright - Only seafood restaurant in town <img src="data:image/png;base64,#images/they_do_exist.gif" width="100%" style="display: block; margin: auto;" /> ] .right-column[ <img src="data:image/png;base64,#images/monopoly_examples.png" width="80%" style="display: block; margin: auto;" /> ] ] .panel[.panel-name[Why Do They Exist?] ### Barriers to entry .pull-left[ 1. Government blocks entry: granting patents, copyrights or trademarks; granting a firm a public franchise (e.g., US Postal Service) 2. Control of a key resource (e.g., DeBeers Diamonds) 3. Network externalities (e.g., Craigslist) 4. Natural Monopoly - a situation in which economies of scale are so large that one firm can supply the entire market at a lower ATC than can two or more firms (e.g., cable) ] .pull-right[ <br> <img src="data:image/png;base64,#images/you_shall_not_pass.gif" width="100%" style="display: block; margin: auto;" /> ] ] .panel[.panel-name[Average Total Cost] .pull-left[ ### ATC for Natural Monopoly In the market for electricity delivery, a single firm (point A) can deliver electricity at a lower cost than can two firms (point B). ] .pull-right[ <img src="data:image/png;base64,#images/fig_15_1.png" width="100%" style="display: block; margin: auto;" /> ] ] ] --- ## Monopoly: Choosing Price and Output .panelset[ .panel[.panel-name[Intro] .pull-left[ The return of marginal cost and marginal revenue - Oligopolies had strategic interaction - Monopolies do not Goal of monopolists - Maximize profit by choosing quantity - Same as perfect and monopolistic competitors ] .pull-right[ <img src="data:image/png;base64,#images/krabs_max_profit.gif" width="50%" style="display: block; margin: auto;" /> ] Downward sloping demand - Similar to monopolistic competition BUT with barriers to entry - So no one can compete away their economic profit So, how does it choose price and output? - Simultaneously where `\(MR = MC\)` - Note, `\(P > MC\)` at this point ] .panel[.panel-name[Marginal Revenue and Marginal Cost] .pull-left[ <table class="table table-striped table-hover table-condensed" style="font-size: 18px; margin-left: auto; margin-right: auto;"> <caption style="font-size: initial !important;">Table: Calculating Monopoly Revenue</caption> <thead> <tr> <th style="text-align:center;"> Stamps per Day </th> <th style="text-align:center;"> Price </th> <th style="text-align:center;"> Total Revenue </th> <th style="text-align:center;"> Average Revenue </th> <th style="text-align:center;"> Marginal Revenue </th> </tr> </thead> <tbody> <tr> <td style="text-align:center;"> 0 </td> <td style="text-align:center;"> 0.85 </td> <td style="text-align:center;"> 0.0 </td> <td style="text-align:center;"> 0.85 </td> <td style="text-align:center;"> NA </td> </tr> <tr> <td style="text-align:center;"> 1 </td> <td style="text-align:center;"> 0.80 </td> <td style="text-align:center;"> 0.8 </td> <td style="text-align:center;"> 0.80 </td> <td style="text-align:center;"> 0.8 </td> </tr> <tr> <td style="text-align:center;"> 2 </td> <td style="text-align:center;"> 0.75 </td> <td style="text-align:center;"> 1.5 </td> <td style="text-align:center;"> 0.75 </td> <td style="text-align:center;"> 0.7 </td> </tr> <tr> <td style="text-align:center;"> 3 </td> <td style="text-align:center;"> 0.70 </td> <td style="text-align:center;"> 2.1 </td> <td style="text-align:center;"> 0.70 </td> <td style="text-align:center;"> 0.6 </td> </tr> <tr> <td style="text-align:center;"> 4 </td> <td style="text-align:center;"> 0.65 </td> <td style="text-align:center;"> 2.6 </td> <td style="text-align:center;"> 0.65 </td> <td style="text-align:center;"> 0.5 </td> </tr> <tr> <td style="text-align:center;"> 5 </td> <td style="text-align:center;"> 0.60 </td> <td style="text-align:center;"> 3.0 </td> <td style="text-align:center;"> 0.60 </td> <td style="text-align:center;"> 0.4 </td> </tr> <tr> <td style="text-align:center;"> 6 </td> <td style="text-align:center;"> 0.55 </td> <td style="text-align:center;"> 3.3 </td> <td style="text-align:center;"> 0.55 </td> <td style="text-align:center;"> 0.3 </td> </tr> <tr> <td style="text-align:center;"> 7 </td> <td style="text-align:center;"> 0.50 </td> <td style="text-align:center;"> 3.5 </td> <td style="text-align:center;"> 0.50 </td> <td style="text-align:center;"> 0.2 </td> </tr> <tr> <td style="text-align:center;"> 8 </td> <td style="text-align:center;"> 0.45 </td> <td style="text-align:center;"> 3.6 </td> <td style="text-align:center;"> 0.45 </td> <td style="text-align:center;"> 0.1 </td> </tr> <tr> <td style="text-align:center;"> 9 </td> <td style="text-align:center;"> 0.40 </td> <td style="text-align:center;"> 3.6 </td> <td style="text-align:center;"> 0.40 </td> <td style="text-align:center;"> 0.0 </td> </tr> <tr> <td style="text-align:center;"> 10 </td> <td style="text-align:center;"> 0.35 </td> <td style="text-align:center;"> 3.5 </td> <td style="text-align:center;"> 0.35 </td> <td style="text-align:center;"> -0.1 </td> </tr> </tbody> </table> ] .pull-right[ <table class="table table-striped table-hover table-condensed" style="font-size: 18px; margin-left: auto; margin-right: auto;"> <caption style="font-size: initial !important;">Table: Profit Maximizing Condition</caption> <thead> <tr> <th style="text-align:center;"> Quantity </th> <th style="text-align:center;"> Price </th> <th style="text-align:center;"> Total Revenue </th> <th style="text-align:center;"> Marginal Revenue </th> <th style="text-align:center;"> Total Cost </th> <th style="text-align:center;"> Marginal Cost </th> </tr> </thead> <tbody> <tr> <td style="text-align:center;"> 3 </td> <td style="text-align:center;"> 27 </td> <td style="text-align:center;"> 81 </td> <td style="text-align:center;"> NA </td> <td style="text-align:center;"> 56 </td> <td style="text-align:center;"> NA </td> </tr> <tr> <td style="text-align:center;"> 4 </td> <td style="text-align:center;"> 26 </td> <td style="text-align:center;"> 104 </td> <td style="text-align:center;"> 23 </td> <td style="text-align:center;"> 73 </td> <td style="text-align:center;"> 17 </td> </tr> <tr> <td style="text-align:center;"> 5 </td> <td style="text-align:center;"> 25 </td> <td style="text-align:center;"> 125 </td> <td style="text-align:center;"> 21 </td> <td style="text-align:center;"> 91 </td> <td style="text-align:center;"> 18 </td> </tr> <tr> <td style="text-align:center;font-weight: bold;background-color: #18BC9C !important;"> 6 </td> <td style="text-align:center;font-weight: bold;background-color: #18BC9C !important;"> 24 </td> <td style="text-align:center;font-weight: bold;background-color: #18BC9C !important;"> 144 </td> <td style="text-align:center;font-weight: bold;background-color: #18BC9C !important;"> 19 </td> <td style="text-align:center;font-weight: bold;background-color: #18BC9C !important;"> 110 </td> <td style="text-align:center;font-weight: bold;background-color: #18BC9C !important;"> 19 </td> </tr> <tr> <td style="text-align:center;"> 7 </td> <td style="text-align:center;"> 23 </td> <td style="text-align:center;"> 161 </td> <td style="text-align:center;"> 17 </td> <td style="text-align:center;"> 130 </td> <td style="text-align:center;"> 20 </td> </tr> <tr> <td style="text-align:center;"> 8 </td> <td style="text-align:center;"> 22 </td> <td style="text-align:center;"> 176 </td> <td style="text-align:center;"> 15 </td> <td style="text-align:center;"> 151 </td> <td style="text-align:center;"> 21 </td> </tr> </tbody> </table> ] ] .panel[.panel-name[Short-Run Profit] <img src="data:image/png;base64,#images/fig_15_3.png" width="80%" style="display: block; margin: auto;" /> ] .panel[.panel-name[Long-Run Profit] .pull-left[ Since there are barriers to entry, additional firms cannot enter the market. - So, there is no distinction between the short run and long run for a monopoly. - Then, unlike for monopolistic competition, we expect monopolists to continue to earn profits in the long run. ] .pull-right[ <img src="data:image/png;base64,#images/bugs_bunny_money.gif" width="100%" style="display: block; margin: auto;" /> ] ] ] --- ## Monopoly: Efficiency and Market Power .panelset[ .panel[.panel-name[Set-up] Suppose that a market could be characterized by either perfect competition or monopoly. Which would be better? Thought experiment: Suppose the market for athletic shoes is perfectly competitive, then one firm buys up all of the shoes in the country. What would happen to: - Price of athletic shoes? - Quantity of athletic shoes traded? - The net benefit of consumers (i.e. *consumer surplus*)? - The net benefit of producers (i.e. *producer surplus*)? - The net benefit of all of society (i.e. *economic surplus*)? ] .panel[.panel-name[PC to Monopoly] #### What Happens If a Perfectly Competitive Industry Becomes a Monopoly? <img src="data:image/png;base64,#images/fig_15_4.png" width="80%" style="display: block; margin: auto;" /> ] .panel[.panel-name[Inefficiency] .pull-left[ Efficiency Loss - With the higher monopoly price, consumer surplus decreases by the areas *A+B*. - Producer surplus falls by *C* but rises by *A*; an overall increase. - Area *A* is simply a transfer of surplus: neither inherently good nor bad. - But areas *B* and *C* are lost surpluses: **deadweight loss**. Monopolist's incentives - `\(MC_M < P_M\)` - If the market were perfectly competitive, this unit would be supplied, and economic surplus would increase. - But this would decrease the monopolist’s profit, so it will not be produced. ] .pull-right[ <img src="data:image/png;base64,#images/fig_15_5.png" width="80%" style="display: block; margin: auto;" /> ] ] .panel[.panel-name[Review] Comparing perfect competition and monopoly - Competition: `\(P = MC\)`, `\(MB = MC\)`, no DWL, in long-run `\(P = ATC\)` - Monopoly: `\(MR = MC\)`, `\(MB > MC\)`, DWL, in long-run `\(P \neq ATC\)` Monopolies are inefficient - both productive inefficiency `\((P \neq ATC)\)` and allocative inefficiency `\((P > MC)\)` Summary of effects 1. Monopoly causes a reduction in consumer surplus 2. Monopoly causes an increase in producer surplus 3. Monopoly causes deadweight loss which represents a reduction in economic efficiency How large is this? - Depends on market power, but is estimated <1% of total U.S. production ($650 per person annually) - Why so low? - Relatively large degree of competition => prices approach marginal cost - So, DWL due to market power is relatively small Any upside to market power? - Maybe via innovation - R\&D is more likely to happen in monopoly markets with profits ] ] --- ## Price Discrimination .panelset[ .panel[.panel-name[Intro] **Price discrimination:** - charging different prices to different customers for the same good or service when the price differences are not due to differences in cost - e.g. movie theater (student/senior discount), airlines, etc. - the idea is to meet people's willingness-to-pay thresholds - Note: not the same as discrimination based on race/gender Price discrimination is possible when: 1. Firms possess market power (not price-taker) 2. Identifiable groups of consumers have different willingness to pay for the product 3. Arbitrage of the product is not possible. **Arbitrage**: buying a product at a low price and selling it for a higher price ] .panel[.panel-name[Auto Ins.] .pull-left[ Gray areas - Car insurance companies typically charge lower prices to women than to men because men have more accidents than women - But what if a car company determined that one race tended to have more accidents than another? ] .pull-right[ <table class="table table-striped table-hover table-condensed" style="font-size: 20px; margin-left: auto; margin-right: auto;"> <caption style="font-size: initial !important;">Table: Auto Insurance Rates by Age and Gender</caption> <thead> <tr> <th style="text-align:center;"> Age </th> <th style="text-align:center;"> Males </th> <th style="text-align:center;"> Females </th> </tr> </thead> <tbody> <tr> <td style="text-align:center;"> 18 </td> <td style="text-align:center;"> $3,506 </td> <td style="text-align:center;"> $3,198 </td> </tr> <tr> <td style="text-align:center;"> 19 </td> <td style="text-align:center;"> $3,069 </td> <td style="text-align:center;"> $2,789 </td> </tr> <tr> <td style="text-align:center;"> 20 </td> <td style="text-align:center;"> $2,884 </td> <td style="text-align:center;"> $2,631 </td> </tr> <tr> <td style="text-align:center;"> 21 </td> <td style="text-align:center;"> $2,543 </td> <td style="text-align:center;"> $2,309 </td> </tr> <tr> <td style="text-align:center;"> 22 </td> <td style="text-align:center;"> $2,596 </td> <td style="text-align:center;"> $2,336 </td> </tr> <tr> <td style="text-align:center;"> 25 </td> <td style="text-align:center;"> $2,247 </td> <td style="text-align:center;"> $2,106 </td> </tr> <tr> <td style="text-align:center;"> 40 </td> <td style="text-align:center;"> $1,778 </td> <td style="text-align:center;"> $1,764 </td> </tr> <tr> <td style="text-align:center;"> 60 </td> <td style="text-align:center;"> $1,612 </td> <td style="text-align:center;"> $1,597 </td> </tr> <tr> <td style="text-align:center;"> 70 </td> <td style="text-align:center;"> $1,755 </td> <td style="text-align:center;"> $1,729 </td> </tr> </tbody> </table> ] ] .panel[.panel-name[Movie Theaters] <img src="data:image/png;base64,#images/fig_15_6.png" width="70%" style="display: block; margin: auto;" /> ] .panel[.panel-name[Perfect Price Discrimination] <img src="data:image/png;base64,#images/fig_15_7.png" width="90%" style="display: block; margin: auto;" /> ] .panel[.panel-name[Results] Price discrimination - We know that price discrimination increases profits for firms (otherwise they wouldn’t do it). - But it also decreases consumer surplus. - Overall, can we say that price discrimination increases economic efficiency (i.e. decreases deadweight loss)? - Unfortunately, not always—the results of price discrimination on overall welfare are ambiguous. Price discrimination across time - A less obvious way in which firms price discriminate is across time. - For example, book publishers often sell a hardcover version, and some months later, release a much cheaper, paperback version. - The production cost is similar. The publisher simply wants to determine who is a huge fan and can’t wait to read the book, and hence is willing to pay more; these people will get charged more. ] .panel[.panel-name[Legality] In 1936, Congress passed the Robinson-Patman Act, an antitrust law that: - outlawed price discrimination that reduced competition - contained language that could be interpreted as making illegal all price discrimination In the 1960s, the Federal Trade Commission tested the scope of this law, - sued Borden Inc. for selling evaporated milk under its own brand, and under a store brand, for two different prices. - The courts ruled that such price discrimination increased rather than reduced competition and have generally followed this pattern in subsequent years. ] ] --- ## Antitrust and Natural Monopolies .panelset[ .panel[.panel-name[Government Policy] .pull-left[ Monopolies `\(\downarrow\)` consumer surplus and economic efficiency, so governments regulate their behavior - Try to stop colluding and to prevent market consolidation (e.g. M&A) through antitrust laws - **Collusion**: An agreement among firms to charge the same price or otherwise not to compete. - **Antitrust laws**: Laws aimed at eliminating collusion and promoting competition among firms. Antitrust laws - In the 1870s and 1880s, several "trusts" had formed to enforce collusive agreements - Government responded with antitrust laws to limit anti-competitive behavior ] .pull-right[ <img src="data:image/png;base64,#images/tab_15_2.png" width="90%" style="display: block; margin: auto;" /> ] ] .panel[.panel-name[Mergers] Antitrust laws also cover mergers and acquisitions - Want to avoid consolidation of market power - Consolidation can lead to increase prices and reduce output Government is mostly concerned with horizontal mergers - **Horizontal mergers** are mergers between firms in the same industry - **Vertical mergers** are mergers between firms at different stages of production of a good Complicated to know beforehand if a merger is good or bad - What's the market? - If Hershey Foods wants to merge with Mars. Inc. (maker of M&Ms, Snickers), what's the relevant market? - If candy, then the new company would have 70% of market share. - If snacks, then smaller. If food, even smaller. - It's possible that the merged firm is more efficient and reduces costs ] .panel[.panel-name[Efficiency Gains] <img src="data:image/png;base64,#images/merger_with_efficiency_gains.png" width="70%" style="display: block; margin: auto;" /> ] .panel[.panel-name[Guidelines] #### DOJ and FTC Merger Guidelines 1. Market definition - Start with a narrow definition of the industry - In Mars example, they start by assuming all candy firms raised price by 5 percent, and check what would happen to profits. - If they fell, then they take a broader definition. They repeat this process until the market has been identified 2. Measure of concentration - a market is concentrated if a relatively small number of firms have a large share of total sales. - **Herfindahl-Hirschman Index (HHI)**: measure of concentration which squares the market share of each firm and sums the values of the squares $$ `\begin{align} \text{1 firm with 100%: } HHI &= 100^2 = 10,000\\ \text{2 firm with 50% each: } HHI &= 50^2+50^2 = 5,000\\ \text{4 firms: } HHI &= 30^2 + 30^2 + 20^2 + 20^2 = 2,600\\ \text{10 firms evenly split: } HHI &= 10*(10)^2 = 1,000 \end{align}` $$ ] .panel[.panel-name[Standards] #### 3. Merger standards .pull-left[ - Post-merger HHI below 1500 - not concentrated, so mergers are not challenged - Post-merger HHI 1500-2500 - Mergers that raise HHI <100 won't probably be challenged, - but >100 might - Post-merger HHI >2500. Highly concentrated. - Change in HHI - Mergers that raised <100 won't be challenged, - 100-200 might be challenged, and - Over 200 likely will be challenged ] .pull-right[ <img src="data:image/png;base64,#images/tab_15_3.png" width="100%" style="display: block; margin: auto;" /> ] ] .panel[.panel-name[Natural Monopolies] .pull-left[ Regulating natural monopolies is complicated. - Competition from other firms will not play its usual role of forcing price down to zero economic profits - Local or state regulator commissions usually set prices - But what price should they set? See the problems that occur when forcing a natural monopoly to set price equal to marginal cost A more common solution is to set `\(P = ATC\)`, thus ensuring zero economic profits - But because of economies of scale, this is less than the efficient level of production ] .pull-right[ <img src="data:image/png;base64,#images/fig_15_8.png" width="100%" style="display: block; margin: auto;" /> ] ] ] ---